There has been a long-felt need to develop financial products with which to hedge price risk for goods and services, and many have appreciated the problem of often volatile changes in prices for goods and services. To date, the search for a solution to this need has been largely fruitless except for products that generally fall within traditional notions of the definition of “fungible”. The creation of hedge products for services has lagged far behind product development for raw commodity products and certain financial instruments, and remains nascent at best. The quest to engineer financial hedge products for non-traditional product classes is well exemplified in the search for electronic component hedges, which search can be seen as an archetype for many diverse products and services in a plurality of industries.
For example, the Chicago Board of Trade, the Chicago Board Options Exchange, Twin Cities Board of Trade, and The Pacific Stock Exchange have been among the exchanges to try to develop futures and option products for such goods as electronic components. In each instance they have tried and failed, or have abandoned the efforts without launch.
Similarly, Enron tried to launch DRAM futures but failed, as predicted by Needham & Co. analyst Dan Scovel. “The problem is that DRAMs are an unstable commodity that undergoes a wide variety of fundamental product changes over time,” Scovel said. “We believe the inherent instability of the offering renders forward contracts impractical.”
For the most part, forward pricing that does exist consists of commitments between manufacturers and users to buy according to build schedules, a traditional method and relationship that are far from what most financial engineers think of when they discuss forward markets. Reports in the electronics industry press that cite a forward pricing market are often misleading in that what is most often being referred to as a forward price is simply a broker's “best guess” as to where components prices will be in some number of days, weeks, or months in the future. Thus, rather than a forward or future price as meant by the financial community, what is usually being spoken of as a forward pricing market is actually a type of price forecasting or speculation that is little different from when stock analysts prognosticate on the likely price of IBM in six months time. Initiatives by certain chip manufacturers to sell production capacity “forward” have met with limited success. A market of very limited scope for options on some individual products exists, but the market is largely unreliable.
Recent efforts by the Singapore Exchange (SGX) to launch futures on DRAM, even with their use of industry experts and consultations with major manufacturers in the work on the contract development, have met with many complaints. At least for the setting of a contract specification, several DRAM manufacturers have qualified for delivery on a proposed specification but industry responses to the product remain mixed, with some believing the market acceptance will be too thin, that the delivery set is too narrow, and that there is still a lack of fungibility. The contract launch has been repeatedly postponed and is still yet to be launched. Many in the industry continue to predict the SGX and other contracts will fail. A similar effort by the Semiconductor Futures Exchange to launch futures on the DRAM, which was chosen by the Semiconductor Futures Exchange because DRAM is “well specified by part number and type”, is also being greeted by skepticism.
The historical reasons for expecting failure in DRAM futures contract trading, and by extension failure in other similar derivative contracts remain in place. Liquidity in cash products can be spotty. Variations in pin counts, packaging and product performance specifications (and how they are obtained) can give the impression of lack of fungibility and, in the absence of a repurchase and reverse repurchase market, the liquidity patterns in the futures contracts (and other derivatives) will be unreliable due to incompleteness in hedging opportunity. While both the Singapore Exchange and Semiconductor Futures Exchange claim to have solved fungibility problems with DRAM, arguably amongst the most highly fungible semiconductor products, for other electronics components the contract design problems for hedge products remain seemingly intractable.
U.S. Patent Application No. 2002/0055886 for System And Method For Maintaining And Utilizing Component Cross Reference Data In An Exchange System discloses a method for normalization of computer part and numbers, and “Part Number Normalization,” a White Paper by River One, explores this idea from a slightly different approach.
The '886 patent application and the White Paper provide ideas for relating electronics components by part numbers, as they are defined internally by equipment manufacturers and by the component manufacturers themselves, in an internally consistent hierarchy of logical equivalency. The method differs from high level generic fungibility because equipment manufacturers define the parts of different manufacturers as fungible to their own particular needs, (often to the level of a specific build in a product class), and assign a system of internal part numbers which are associated with specific manufacturer part numbers. In the '886 application, the internal part numbers of one component user are related to the part numbers of individual component manufactures and to the internal part numbers of other component users to create lists of possibly interchangeable parts.
While a certain amount of the above can be inferred by examining and comparing printed specifications, a major effort by manufacturers goes toward defining fungibility according to uses of the parts and is the result of the impetus for rigorous suitability-to-purpose testing by engineers. This kind of a suitability certification is designed to provide for alternative parts where they exist (e.g., to preclude production line shut downs that can and do occur as a result of shortages in a particular part, whether due to manufacturer failures to deliver or an absence of supply in the spot market). It is an unpleasant reality for computer manufacturers, for example, that the lack of a single $0.05 capacitor could close down an entire production facility. These substitution designations are essential to maintaining operating production lines, the loss of which is of such criticality to company health as to justify the high expense of testing and certification for suitable substitutes whenever they exist. In fact, this expensive effort can be viewed as a form of “build insurance.”
Prior to these and similar comparison regimes, a search for alternatives using specification lists might show no suitable substitution candidates or require extensive research. But under this methodology, a part that might seem non-fungible from a specification sheet could be revealed to be fungible in a particular situation. For example, in a product requiring a component with a response time of 30 microseconds and an operating voltage range of 10 to 25 millivolts, a fungible component might be a similar device with a response time of less than 20 microseconds with an operating voltage of 15 to 20 millivolts, while a component operating at 30 microseconds or less in a voltage range of 5 to 10 millivolts would not be fungible because the operating voltage of the main product has a ten millivolt lower bound.
Similarly, once a substitute has been identified on the basis of response time and voltage boundaries, vibration tolerances might enter the substitution sort. Thus, a product requiring a high vibration tolerance would have a different set of suitable components than a low vibration tolerance product. Further, there can be additional individual specifications such as date codes, shock, and temperature tolerance to define fungibility by use. Standard data sheets, and databases comparing standard data sheets, likely will not produce the desired results. Similarly, many of the web sites that specialize in electronic component tracking and comparisons are limited by the fact that they are only making substitutability suggestions, not certifications. A prototypical method for automating the search for components is described in “Component Advisor: A Tool for Automatically Extracting Electronic Component Data from Web Datasheets”, published by Hewlett-Packard Laboratories.
The capacity of a computer-based database system and computerized methods to establish functional equivalence between seemingly unrelated parts, and thereby define degrees of fungibility in terms of their application, opens to development the possibility for active and liquid trading in financial products of all types for the electronics industry, as well as for other goods and services where substitutability or interchangeability either exists, or is developing but is not necessarily apparent.
Moreover, the creation of financial products enhance the liquidity of trade in the cash market by allowing for easy borrowing and lending (under repurchase and reverse repurchase methods) from a defined subset or entire set of fungible parts to underpin short selling. Such short selling is requisite to efficient hedging of financial products by dealers and traders, and the development of short selling itself is dependant on the ability to borrow inventory which is sold so delivery can be made even when the subject inventory is not yet owned. This borrowing function is typically supported by the financial mechanism of “repurchase” and “reverse repurchase”. Repurchase and reverse repurchase can be defined as follows:
Repurchase—A customer sells an asset and receives cash with the intent and obligation of buying the asset back, usually at the same price with an interest rate based cost attached to the transaction (hence the term “repurchase agreement”).
Reverse Repurchase—A customer buys an asset and releases cash with the intent and obligation of returning the asset for the cash, at an arranged price with an interest rate based profit attached to the transaction (hence the term “reverse repurchase agreement”).
Repurchase agreements are typically referred to as “repo” and Reverse repurchase is typically referred to as “reverse” or “reverse repo”.
There are many repo structures that are variations on a theme, but typical to most of them is that the sale/buy back is collateralized by liquid assets, making repurchase an efficient and low cost method of financing holdings and providing inventory for short sellers to deliver against their sales. It is the method of repo that drives much liquidity in the US Treasury debt and stock markets, for example, and repo and reverse are businesses in their own right earning significant sums of money for banks and securities houses.
In contrast to the below approach of the present invention, consider the very different methods of identifying securities by using a Committee on Uniform Securities Identification number (CUSIP). Under the CUSIP system, each individual security has an individual CUSIP number associated with that security and that security only, much as manufacturers assign part numbers to production. Under the methods of the above mentioned '866 application, each manufacturer part number is related to a user's internal part number and the internal part numbers of multiple users are compared and related to suggest interchangeability. Under this methodology, multiple seemingly non-equivalent parts can be assigned a universal part number, but that “universal” part number identifies only a possible match and a given related part may not work in a specific application. Further, among the differences that separate a part equivalency numbering system from a CUSIP system is that the definitions of equivalency are subject to change according to testing, use, and preference criteria. In fact, under a part equivalency numbering system, an end user can simply refuse to recognize a given part as interchangeable with an originally specified part. CUSIP identifications are not negotiable or flexible, market participants can not refuse to recognize the designated security they define and they do not represent sets of fungible products in the manner contemplated by the subject invention.
U.S. patent application Ser. No. US2002/0026429 A1, Transactional Method And System For Semi-Fungible Commodity Items, describes a system and method for trading goods and services according to a set of micro-economic utility functions that defines their fungibility under an imprecise regime of “it isn't exactly what I want, but for this price, it will do.” The '429 patent application attempts to define a fungibility mechanism as the basis for bulk transactions and does not appear to contemplate fungibility on any basis other than the negotiation model of a flea market, though it does couch that negotiation model in terms of formal econometric terminology, graphs and modern technology.